Discussion:Forfeited House Deposit

Milt Baker CPA Michigan

The IRS is using the logic of 1234B (seller of house as grantor of put/call; buyer out of luck since short-term capital loss from 1234A is non-deductible) and thus treats any such gain as ordinary income.

"In general, any gain to the grantor of an option arising from the failure of the holder to exercise it, and any gain or loss realized by the grantor of an option as a result of a closing transaction, such as repurchasing the option from the holder, is considered ordinary income or loss."

From the layman's publication 523: "Option to buy. If you grant an option to buy your home and the option is exercised, add the amount you receive for the option to the selling price of your home. If the option is not exercised, you must report the amount as ordinary income in the year the option expires. Report this amount on Form 1040, line 21, or on Form 1040NR, line 21. "

Milt Baker CPA Michigan

     Gain or loss attributable to the cancellation, lapse, expiration,
   or other termination of -
       (1) a right or obligation (other than a securities futures
     contract, as defined in section 1234B) with respect to property
     which is (or on acquisition would be) a capital asset in the
     hands of the taxpayer, or
       (2) a section 1256 contract (as defined in section 1256) not
     described in paragraph (1) which is a capital asset in the hands
     of the taxpayer, 
   shall be treated as gain or loss from the sale of a capital asset.
   The preceding sentence shall not apply to the retirement of any
   debt instrument (whether or not through a trust or other
   participation arrangement).

Question" Site. Not surprised at the answer

IRS Email Tax Law Assistance:

Your Question Was: A potential buyer gives you a deposit on the potential sale of your home. The buyer backs out and you have a forfeited deposit Is this ordinary income or capital gain?

The Answer To Your Question Is: Thank you for your question. This income, from a forfeited deposit, would be treated as ordinary income, and reported on line 21 of Form 1040, or on Form 1040NR, line 21. This answer is found in Publication 523, Page 4, Option to buy.

Milt Baker CPA Michigan

Failure to exercise option. If the holder of an option to buy or sell property incurs a loss on failure to exercise the option, the option is deemed to have been sold or exchanged on the date that it expired. Any such loss to the holder of an option is treated under the general rule provided in paragraph (a) of this section. In general, any gain to the grantor of an option arising from the failure of the holder to exercise it, and any gain or loss realized by the grantor of an option as a result of a closing transaction, such as repurchasing the option from the holder, is considered ordinary income or loss. However, for the treatment of gain or loss from a closing transaction with respect to or gain on the lapse of an option granted in stock, securities, commodities or commodity futures, see section 1234(b) and §1.1234–3.

One of the requirements for capital gain or loss is that there is an exchange or sale. Income from a options lapse is not considered from a sale or exchange. Hence, ordinary income.